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Evergrande and the intricacies of Chinese insolvency law

By Jiawei Wang, Partner at Roedl & Partner
Jiawei Wang is an expert in Chinese law

For 20 years, a myth has prevailed in the Chinese economy: real estate prices always rise. With the construction boom, China has seen the emergence of numerous ever-growing real estate companies. Evergrande is a prime example of the robust past of China’s real estate sector. Thanks to its success story in the real estate market, the Group is now also active in various other sectors: the Group runs a professional soccer club, is an asset manager, plans to build EVs, and is active in the healthcare sector.

The Chinese real estate market is overheated

But the supposed “perpetuum mobile” of the ever-growing real estate market is just a fantasy. Market analysts have warned several times that the real estate bubble will burst. Lately, it has become apparent that the Chinese real estate market has cooled down. The rise in real estate prices in China has slowed down. In some cities, prices have even dropped. This brings Evergrande back down to earth. There are also the bitter results of the diversification strategy: Its EV is not yet running, and financially, the Guangzhou Evergrande soccer club is more resembling FC Barcelona than FC Bayern Munich. Evergrande’s debt crisis is not government-made. Instead, it originated from within Evergrande – or rather, is a market-driven result.

Several creditors are counting on the Chinese government (at the national or regional level) to intervene and put together a rescue package. In particular, private individuals who bought apartments from Evergrande are hoping that Evergrande will resume construction work and fulfill their part of the contract. To date, however, no rescue package has been announced by the state.

Is there an exit strategy?

We assess that the Chinese government will not be willing or able to offer an extensive rescue package for Evergrande. The scope of the crisis is not yet clear. The domino effect of the state using taxpayers’ money to bail out a company whose mismanagement contributed greatly to its downfall should also be considered. In the difficult Covid period, China’s central bank certainly has more pressing challenges to tackle than becoming the country’s largest real estate investor.

It is possible, however, that in individual cases, state-owned enterprises or state-managed investment funds could participate in a restructuring of the company concerned in the Evergrande Group or assume certain debts. In such cases, however, SOEs and SOE-led investment funds are regular market players like any other potential investors in a Chapter 11 case. We believe that such participation by state-owned enterprises or state-managed investment funds is most likely to occur when the interests of a larger group of private individuals would be adversely affected.

Chinese bankruptcy law

Economically, the Evergrande Group is at rock bottom. Legally, however, the picture is highly interesting: Evergrande has not yet filed for bankruptcy. This means that, by law, Evergrande is still alive.

In China, bankruptcy procedures are mainly regulated by the Enterprise Bankruptcy Law, which came into force on June 1st, 2007. As in Germany, bankruptcy procedures in China are filed with the competent court (People’s Court). In practice, the investor may encounter problems. Bankruptcy procedures in China differ greatly from procedures in Germany. The main difference between the two bankruptcy systems is that the concept of delaying bankruptcy does not yet exist in mainland China in a form comparable to that in Germany. The Chinese Enterprise Bankruptcy Law does not set a fixed deadline for when a company must file for bankruptcy. From a German perspective, bankruptcy petitions are often filed too late in China. This is the legal ground on which Evergrande currently still rests.

Moreover, it should not be overlooked that, in its current form, Evergrande’s influence extends beyond China’s borders. The Evergrande Group is listed on the Hong Kong Stock Exchange and registered in the Cayman Islands. In this case, the company must comply with the laws of the Cayman Islands, as well as the listing rules of the Hong Kong Stock Exchange. In this regard, it cannot be ruled out that a mandatory measure, such as delisting, may occur earlier than the bankruptcy filing in China.

What else can be expected?

What does Evergrande’s liquidity crisis mean for foreign creditors? Unlike Chinese creditors, foreign creditors are mostly institutional investors. Chinese bankruptcy law certainly does not exclude foreign creditors. To this end, the principle of equality applies: neither disadvantage nor advantage. Preference over Chinese creditors or consumers would be an illusion. On the other hand, nerve-racking creditor meetings are likely. It remains interesting to see, if and how Evergrande – and also the state – will overcome the crisis. “Too big to fail” does not exist in the Middle Kingdom.

Jiawei Wang LL.M. is Legal Counsel and Partner at Roedl & Partner in Stuttgart. He studied law in Shanghai and Heidelberg and is admitted to the bar of the People’s Republic of China as Lu Shi (lawyer under Chinese law). Wang represents, among others, German industrial companies in contract negotiations and legal disputes with Chinese business partners.

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